BarroMetrics Views: Deflation, Inflation?
I found last night’s response on CNBC to the PPI number as interesting. The anchors clearly felt that despite all the trillions spent that the US does not have (quantative easing) and the fact that the US debt is 60% of GDP, the danger was deflation, not inflation.
Do they have a point?
For an answer, I want to turn to China. And the reason for this is, like the Chinese embarked on a massive spending spree e.g. in the 6 months of 2009, the Chinese banks lent US$1.1 Trillion; and in the first week of 2010, they lent US$88 billion, more than twice the average of the last 6 months of 2009.
Reuters reported: ” Finance Minister Xie Xuren said China would stick to its pro-growth fiscal stance, warning that withdrawing stimulus spending too early could damage the economy.”
That’s what he said – but what was China doing?
Figure 1 provides the answer. In August 2009, the Chinese Govt started to show signs of concern at the inflation rate. The Shanghai Index responded to some tepid measures by falling from 3478 to 2639 (-24%). In Sept, they reversed themselves but by the first quarter 2010, they again started taking mini-steps to contain inflation. The Shanghai Index responded by breaking below 2639; my view is if the Chinese Government holds its nerve, we’ll see the Shanghai Index test the 1664 lows.
In the US, the banks have been holding on to the money created by the FED. Figure 2 shows only a marginal drop at the St Louis Fed of the Adjusted Monetary Base (AMBs show bank deposits with the FED).
Now here’s my take: until the ABM starts to flow to Main Street, we won’t see any signs of inflation. But unless ABMs do flow, small and medium size businesses will not be able to recover their health. And until the do, the US job front and the economy will remain fragile.
But here is the problem the FED will face: when the ABMs do flow, the US will face the problems China experienced without China’s economic health and reserves.
That’s when inflation will prove to be a problem.
In the meantime, we can expect to see tepid signs from the monthly numbers. Calls for even more quant easing will only create problems further down the track -with current future problems already promising to be a great challenge for the FED to maintain just the right balance between inflation and deflation.
FIGURE 1 Shanghai Index and S&P
FIGURE 2 St Louis FED Adjusted Monetary Base